FairTax Overview
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and virtually alone in failing to adopt a border-adjustable destination based consumption tax.
High Rates Diminish Foreign Investment and Discourage Repatriation.— How do these
anachronisms perversely influence corporate decision-making and impede competitiveness?
At the core of our international tax system, as most tax policy gurus know, is the principal of
extraterritoriality. What this principal means in the context of outbound transactions is that the U.S.
system will tax its individual residents and citizens, and corporations on their worldwide income under
the rates specified in IRC section 1 and 11 (the individual and corporate rates), regardless of where that
income is derived. U.S. taxpayers engaged in activities abroad generally compute taxable income in the
same manner as U.S. taxpayer producing solely with the U.S. Because the norm of international
juridical taxation, with the U.S. generally follows, cedes the primary taxing authority to the country or
territorial connection (i.e., where the income is earned) and the residual taxing authority to the county of
residence, the U.S. seeks to avoid double taxation by crediting any income taxes paid to the foreign
country, against the income tax otherwise due in the U.S.8 One of the largest exceptions to deferral is,
of course, Subpart F, which was introduced in the Kennedy Administration in exchange for lowering
rates, and is intended to discourage U.S. corporations from redirecting income outside the U.S. in order
to avoid immediate U.S. taxation.
While the extraterritorial credit system is at least in theory straightforward -- by crediting the foreign
taxes paid on the foreign income up to the rate of tax imposed on that income we seek to avoid taxing
the same income twice -- it is ridiculously complex in application. That is because before one can
determine what credit can apply, the U.S. resident, citizen or corporation must first determine where the
income and deductions are sourced under an elaborate set of rules, modified further by treaty and the
intercompany transfer pricing rules. One must determine whether and to what extent the foreign taxes
are even creditable. One must then compute the direct and indirect credit (on dividends) by distributing
the income within more than nine separate “baskets” for which the foreign tax credit is individually
limited – enough baskets to turn any sane individual into a “basket” case. And neither least nor last,
before determining the credit to which one is entitled, one must determine if deferral from a subsidiary
must yield to any one of the separate rules under Subpart F pertaining to Controlled Foreign
Corporations.
Because the U.S. is virtually alone in trying to tax its multinational corporations on their foreign
earnings, it incentivizes companies to avoid those taxes indefinitely by keeping profits overseas. That in
turn encourages companies to use accounting maneuvers to shift profits to low-tax countries and to
invest profits offshore. However badly U.S. multinational corporations who earn money overseas want
to bring that money back home to the U.S., our international tax system discourages, and some would
say “penalizes” repatriation of foreign earnings by imposing a 35 percent residual U.S. tax at the time of
repatriation. As a result, several high-profile U.S. multinational corporations are sitting on large piles of
cash earned from foreign operations. Yet these same corporations are actually borrowing money rather
than repatriating their offshore cash.
How much money is trapped offshore? U.S. multinational companies MNCs currently hold an
estimated $1.4 trillion in foreign earnings overseas. About $581 billion in after-tax dividends will be
8
A U.S. parent of a foreign subsidiary is generally not taxed on the earnings of the subsidiary until distributed at which time
the credit is imputed. (IRC section 951-960.
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